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An Even Better Way to Play Oil With Options

Yesterday I sent you a note describing an interesting way to make some serious money with options, betting that the price of oil will either stabilize or move higher from today’s low levels.  Thanks to subscriber Thomas, there is a better underlying out there.  Just in case you were planning to place the trades, I thought you should check this one out first.

Terry

An Even Better Way to Play Oil With Options

This is a re-write of yesterday’s letter, except the underlying is USO (another ETF) rather than OIH.  The chart for USO is remarkably similar to that of OIH:

The chart for USO is remarkably similar to that of OIH:

USO Historical Chart 2015

USO Historical Chart 2015

There is a distinct advantage to USO, however.  The options are far more liquid and bid-ask spreads are much smaller for USO.  In other words, you can get much better prices when you place orders or roll over your short positions to the next month.

USO closed at $19.60 Friday.  Here are the trades I plan to make today:

Buy 3 USO Jan-16 19 calls (USO160115C19)
Sell 3 USO Mar-15 19.5 calls (USO150320C19.5) for $1.45 (buying a diagonal)

Buy 1 USO Jan-16 19 call (USO160115C19) for $3.35
The spread order is priced at $.02 higher than the mid price between the bid and ask price for the spread, and the single call order is placed at $.05 higher than the mid price between the bid and ask.  You should be able to get those prices.

If you got those prices, your total investment would be $435 plus $335 plus $5 commission (Terry’s Tips commission rate at thinkorswim) for a total of $775.

This is the risk profile graph for these positions when the March calls expire on March 20:

USO Risk Profioe Graph 2015

USO Risk Profile Graph 2015

The graph shows that if the price of USO ends up in a range of being flat or moving higher by $3, the portfolio should gain at least $200, or about 25% for the six weeks of waiting.  The nice thing about owning options is that you can make this 25% even if the ETF doesn’t go up by a penny (in fact, if it actually is flat, your gain should be $327, or over 40%).  If you just bought USO instead of using options, you wouldn’t make anything if the ETF didn’t move higher.

Even better, if USO falls by a dollar, you still make a profit with the options positions.  If you owned the ETF instead, you would lose money, of course.

Owning an extra uncovered long Jan-16 19 call gives you upside protection in case USO moves dramatically higher.  It also leaves room to sell another short-term call if USO drifts lower instead of remaining flat or moving higher. Such a sale would serve to reduce or eliminate a loss if the ETF moves lower.

When the March calls expire, you would buy them back if they are in the money (i.e., the ETF is above $19.50) and you would sell Apr-15 calls at a strike slightly above the current ETF price.  You should be able to collect a time premium of about $100 for each call you sell.

There will be 10 opportunities to sell one-month-out calls for $100 before the Jan-16 calls expire. It is conceivable that you could collect $300 every month and get all your mney back in 3 months, and further  sales would be clear profit.  As long as the Jan-16 calls are in the money when they are about to expire, you would collect additional money from those sales as well.

This strategy involves making trades around the third Friday of each month when the short-term short options are about to expire.  That could be a pain in the neck, but to my way of thinking, it is a small price to pay for the possibility of doubling my money over the course of a year.  There is a variety of other option strategies you might employ, but this one makes good sense to me.

 

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